Keith Hennessey examines a provision of the two-year transportation bill that may have reduced deficits on paper, but only by potentially increasing liabilities in the future. The full blog post is well worth a read and offers an interesting example of the budget gimmicks that politicians use in the PAYGO process.

The Pension Benefit Guaranty Corporation (PBGC) is a government-run insurance company that protects pensioners against the risk that their company's plan won't be able to pay promised benefits. This insurance, of course, creates a classic moral hazard problem where companies have an incentive to underfund their pensions -- one which is at least partially addressed through regulations of PBGC-insured plans, including a legally required minimum contribution firms must make to their pension plans.

Congress wisely decided to raise PBGC premiums, given that the insurance program, itself, is underfunded. At the same time, though, Congress unwisely lowered the firm's required minimum contribution to pension plans -- allowing them to assume a higher "discount rate" when pre-funding benefits than currently.

Reducing pension contribution requirements will produce additional revenue in the short term, because the ability of companies to reduce payments to pension plans means companies have higher taxable income and government tax receipts will increase correspondingly. Unfortunately, the near term revenue gain would be wiped out in the long term, because companies would have to increase pension contributions to make up for the earlier years, producing the opposite effect on revenue.

Unfortunately, this provision could allow firms to underfund their pensions more significantly, leaving PBGC on the hook for the difference.

Given PBGC's own financial troubles Hennessey predicts the taxpayers will ultimately pick up the tab:

Some day in the future firms with defined benefit pension plans will go bankrupt, their retirees will be shafted, and Congress will be pressured to make taxpayers finance a PBGC bailout. Members of Congress will give angry speeches and everyone will ask how this could have happened. The answer will be in part that Members of Congress voted for and the President signed this highway bill containing this “pension funding stabilization provision.”

Despite this additional risk, the most likely scenario within the ten year window is that this provision will reduce the deficit. Lower deficits and lower payments by companies sure seems like a win-win to lawmakers. As Hennessey notes:

Now for the kicker: in many cases the labor leaders who represent the firms’ employees cooperate in this effort. Management and labor leaders team up, both to underfund the DB pension plan and to lobby Congress to allow them to do so. This frees up immediate cash in the firm, which management and labor then wrestle over....

The firm managers lobby Republicans in Congress and the labor leaders lobby Democrats. “Give us pension funding relief,” they argue. Members of Congress and staff, who are used to management and labor doing battle, are happy to see that at least on this issue they agree. There is then a strong bipartisan push for a legislative “fix” for pension funding “relief” which allows the continued underfunding of both the DB plans and the PBGC to continue.

No one lobbies on behalf of future retirees who face increased risk of having their pension benefits cut when their employer goes bankrupt. No one lobbies on behalf of the taxpayer who faces increased risk of paying for a future PBGC bailout

Unfortunately, lawmakers have not focused on the potential long-term consequences or risks of this scenario, though they are very real. The IMF has warned of these kinds of "hidden borrowing" schemes which will only weaken our future fiscal position even if it appears to improve the near term position. When bailouts are needed, they will be unexpected and very likely will cost more than premiums that are raised in this bill.

We stress the difficulty of deficit reduction because reasonable fiscal restraint is really hard. There are certainly efficiencies to be had and opportunities for for parato improvements -- but if a policy seems too good to be true, it probably is. We aren't going to be able to gimmick our way out of our current fiscal situation, and the more policymakers try to do so the less credibility they will have when actual savings are proposed.